Your Money; Preaching Gospel of ESOP's For Family-Owned Business

By Jan M. Rosen

Published: September 26, 1992

ALTHOUGH her official title at the Chemical Bank is vice president, structured finance, Deborah P. Baker takes obvious delight in the one bestowed on her by clients and colleagues -- "the ESOP lady."

Ms. Baker preaches the gospel of employee stock ownership plans, or ESOP's, to privately owned businesses throughout the Northeast as a way to solve several problems at once, while minimizing taxes for the families who own the businesses.

"As a financial planning tool, they are incredibly powerful," she said in a recent interview in which she and John E. Colburn Jr., president of Bertholon-Rowland of Media, Pa., described an ESOP his company recently completed, with financing from Chemical.

Bertholon-Rowland, which has 125 employees in Pennsylvania and New Jersey, develops and administers group insurance plans for a large number of professional organizations, including the Pennsylvania and New York State Bar Associations; the Pennsylvania Medical Society and 52 Pennsylvania county medical societies; the New Jersey, New York and Pennsylvania Associations of Realtors, and the Pennsylvania Society of Public Accountants, among others.

Bertholon-Rowland, which is not related to a similarly named New York company founded by the same families in the 19th century, is planning to change its name to Colburn Group Benefits, Mr. Colburn said.

Patrick J. Ryan, another Chemical vice president who worked on the deal, said, "Prior to the ESOP two-thirds of his business was owned by descendants of founders who were not in the business."

That can create a classic conflict where people not in the business want a strong dividend, while people in the business want to plow profits back into it to make it grow, as well as to reward themselves and their employees for their work.

Mr. Colburn cited other considerations. His grandfather had joined the Bertholon-Rowland families shortly after the company was founded as an owner. He passed his share of the business on to his son, John E. Colburn Sr., who is now chairman.

"Father wanted to retire and maintain his income," Mr. Colburn said. He and his sister, Catherine Colburn, senior vice president, wanted control of the company, "and the Bertholon-Rowland families wanted the highest value possible," he continued. "The ESOP facilitated all of this."

Ms. Baker said, "In addition, John can count on improved profitability because of the enthusiasm among employees generated by the ESOP."

In broad terms, the way the deal works is that legal papers creating an ESOP were drawn up. The company borrowed money from Chemical and then lent it to the ESOP, which used it to buy the shares held by the Bertholon-Rowland families. The company is recapitalized with both common and preferred shares, similar to the strategy used in a traditional estate freeze. The ESOP has convertible preferred shares, which are allocated to employees. They pay a dividend but are nonvoting. The Colburns get the common stock, which is voting but pays no dividend.

ESOP's, of course, must be individually tailored for each company to meet particular goals involving current income, succession and future viability of the business and giving employees the incentive of ownership, but the Bertholon-Rowland deal is fairly typical of how these goals can be met.

The tax benefits for both the company and the shareholders, while complicated, can be substantial. Ms. Baker said that by "freezing" the value of the older generation's stock when it was issued, estate taxes, which run as high as 55 percent at the Federal level, were kept down. The older couple can even use their entire unified gift and estate tax credit of $1.2 million immediately by giving stock worth that much to their children tax-free, rather than bequeathing it to them. If it appreciates, fewer shares would use up the credit in the future, she noted.

The older generation can also keep down estate taxes by making annual gifts of stock to younger family members or others, since annual gifts of up to $10,000 per recipient are not subject to gift taxes.

In addition, to get money from their holdings or to diversify them, under Section 1042 of the Internal Revenue Code, owners may take out margin loans on their stock, rather than sell it, and thereby avoid capital gains tax, Mr. Baker said. When they die, their heirs will get the stock at a stepped-up basis, so capital gains taxes can be avoided altogether, she added.

Mr. Colburn said, "One of the exciting things for Cathy and me is that we now have securities that have a market value."